How to optimize your inventory carrying costs?

What is inventory carrying cost?

Inventory carrying costs refers to the total cost of purchasing and holding inventory until it is sold off. .

It thus includes direct costs related to the purchase of inventories and :

• Indirect storage costs

• Insurance costs

• Labor

• Obsolescence

What's it made of?

Inventory carrying costs mainly comprise the following items :

Inventory financing costs

Inventory financing is the financing method used to purchase inventory . This can be supplier credit, bank credit or factoring.

The cost generated by the financing method used is included in inventory carrying costs, as it is what enabled the purchase of inventory. It includes :

• Interest rates

• Ancillary costs associated with arranging financing

• Other indirect costs (e.g. penalties for late payment)

Storage costs

Storage costs are the costs incurred by :

• Conservation

• Handling

• Inventory management at the storage site

They can be particularly important for companies with large inventories.

They include :

• Warehouse rental or purchase costs

• Salaries for permanent employees like security guards

• Insurance costs

• Maintenance costs for handling equipment

• Etc.

On the other hand, when inventories are tied up for too long, they also give rise to financial costs linked to the immobilization of the capital used to purchase them .

Stock obsolescence and depreciation

When inventories are tied up for too long, they eventually lose their value or usefulness due to external factors such as changing fashions or technological developments.

This is what we call obsolescence, a cause of stock depreciation .

This leads to financial losses for the company which can be accounted for under inventory carrying costs.

How to calculate inventory carrying costs?

Calculating the cost of owning stock is an essential operation for any company wishing to optimize its cash flow management.

Cost of ownership calculation methods

There are different methods for calculating inventory carrying costs:

Calculating the weighted average cost of inventories

The weighted average cost (WAC) method consists of consider the average purchase price of goods weighted by the quantities held.

Here is the formula used to apply it:

CMP = Total value of incoming inventory / Total quantity of incoming inventory

In this formula :

• Total value of incoming inventory corresponds to the sum of the costs of products held or acquired (unit price x total quantity)

• Total quantity of incoming inventory = total units available following new supply

This method is generally used by companies storing non-perishable raw materials.

It has the advantage of being easy to implement, making it ideal for simplifying inventory management.

On the other hand, it can be unreliable in the event of major variations in purchase prices.

The Wilson model and economic order quantity (EOQ)

Also known as EOQ, the Wilson model is a method for anticipate order frequency for optimal inventory management .

In other words, this method calculates the optimum order volume and when to place the order to reduce inventory carrying costs.

The Wilson model formula involves the following elements:

• The level of demand for a product

• Storage costs

• The cost associated with the order

This method offers the following advantages:

• Lower acquisition and storage costs

• Optimization of stock levels for each product

• Avoid stock-outs

However, the Wilson model also has its limitations. To use it, a company must meet the following conditions:

• Constant demand for raw materials

• A purchase price that remains unchanged over time

Formula for determining inventory carrying costs

The inventory holding cost formula involves the holding rate and average inventory.

Ownership rate and average inventory

Here is the formula to obtain the inventory carrying cost:

Cost of ownership = Ownership rate x Average inventory

In this formula, the possession rate is an indicator that measures the total annual cost of owning a product in relation to its actual value.

Average stock, on the other hand, corresponds to the average quantity of products held during a given period.

Le calcul du TCO (Total Cost Ownership)

Translated as "total cost of ownership" in French, TCO is a method of evaluating the overall cost of owning a product.

It includes :

• Initial purchase price

• Cost of ownership

• Cost of use

• Exit cost

In other words, we can say that the TCO is actually a synonymous with inventory carrying costs but with a more global approach.

Strategies for optimizing inventory carrying costs

Here are our tips for optimizing inventory carrying costs:

Reduce financing costs

You can reduce financing costs by reducing inventory levels and adopting alternative financing methods.

Optimize stock levels

Poorly managed stock levels not only lead to poor warehouse utilization, but also increase storage costs. Here are some strategies to help you optimize your stock levels:

• Le Just in time (Juste-à-temps) (JAT) which consists of ordering raw materials and products when the company needs them, to limit storage costs.

• Lean inventory to focus efforts on fast-moving products and eliminate overstocking

• The ABC method to optimize the storage of high value-added, fast-moving products (category A), while limiting stocks of less strategic products (B and C).

Alternative financing strategies for inventories

These days, there are a number of innovative financing solutions that enable you to finance your inventory purchases at lower cost.

• Factoring . This is a financial mechanism that enables you to sell your accounts receivable in exchange for immediate cash. Hero uses this solution. By advancing the payment of your accounts receivable, you benefit from liquidity to finance your inventory purchases.

• Le revenue based-financing . This is a form of financing in which a cash advance is obtained in return for a percentage of future profits. Hero also offers this type of financing. When purchasing stock the platform advances the amount of supplier invoices . You then have to pay it back, while benefiting from payment facilities such as instalments.

Reduce storage costs

Here are our tips for reducing storage costs:

• Warehouse centralization . You can cut costs by consolidating all your stock in a single warehouse.

• Optimizing space utilization in warehouses to reduce unused floor space

• Negotiating with logistics service providers to reduce fixed costs

• Automate inventory management using WMS software

Avoid stock obsolescence

Inventory obsolescence is synonymous with financial loss for a company. Here's how to avoid it:

• Apply the LIFO (Last In, First Out) method which allows you to sell older items first

• Keeping track of high-risk products . The aim is to identify the items most likely to become obsolete, so that they can be sold off more quickly.

• Optimize returns and minimize losses by reselling returned products

Hero helps you reduce your inventory carrying costs

Hero is a payment solution that helps you reduce your inventory carrying costs by advancing your stock purchases.

The platform then allows you to pay back your money while benefiting from payment facilities such as fractional payments. in 3 or 4 instalments ou deferred payment after 60 to 90 days.

With Hero, you can purchase inventory even when you don't have the necessary liquidity.

In a nutshell, inventory carrying costs is of strategic importance in company management.

It's vital to keep it to a minimum by avoiding obsolescence, reducing stock levels and automating inventory management. Hero can also help you optimize your costs with innovative and affordable financing solutions.